MIDWEST HOLDING INC.
The following discussion of our financial condition and results of operations
should be read in conjunction with the financial statements and the notes to
those statements included in this Annual Report on Form 10-K and it includes
many forward-looking statements which involve many risks and uncertainties
including those referred to herein. Our actual results could differ materially
from those indicated in such forward-looking statements as a result of certain
factors, such as those set forth herein under "Special Cautionary Note Regarding
Forward-Looking Statements," "Summary of Risks Associated with our Business and
Voting Common Stock" and "Risk Factors." We are under no duty to update any of
the forward-looking statements after the date of this annual report to conform
these statements to actual results.
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Overview of Company and Business Model
Midwest Holding Inc. ("Midwest," "the Company," "we," "our," or "us") was incorporated onOctober 31, 2003 for the purpose of operating a financial services company. We are in the annuity insurance business and operate through our wholly owned subsidiaries,American Life & Security Corp. ("American Life"), 1505Capital LLC ("1505 Capital"), and our sponsored captive reinsurance company,Seneca Reinsurance Company, LLC ("Seneca Re"). We are a financial services company focused on helping people plan and secure their future by providing technology-enabled and services-oriented solutions to support individuals' retirement through our annuity products. We distribute our annuities through independent distributors who are primarily independent marketing organizations ("IMOs"). Our operations are comprised of three distinct, inter-connected businesses - insurance, reinsurance, and asset management. We seek to reinsure a significant portion of our annuity policies with third-party reinsurers and our captive reinsurance subsidiary, Seneca Re. Our third-party reinsurers include traditional reinsurers and capital markets reinsurers, who are investors seeking exposure to reinsurance revenue and typically do not have their own reinsurance platforms or insurance-related operations. We also have the flexibility to selectively retain assets and liabilities associated with our policies for a period of time when we expect that doing so will provide an attractive return on our capital. We believe that our operating capabilities and technology platform provide annuity distributors and reinsurers with flexible and cost-effective solutions. We seek to create value through our ability to provide the distributors and reinsurers with annuity product innovation, speed to market for new products, competitive rates and commissions, and streamlined customer and agent experiences. Our capital model allows us to support increasing annuity sales volumes with capital capacity provided by reinsurers although, in connection with plans for future growth, we continue to monitor any need for additional capital. By reinsuring a significant portion of the annuity policies issued, the level of capital needed for American Life is significantly less than retaining all of the business on its books. We believe this "capital light" approach has the potential to produce enhanced returns for our business compared to a traditional insurance company capital structure. This strategy helps reduce our insurance regulatory capital requirements because policies that are reinsured require substantially less capital and surplus than policies retained by us. As ofDecember 31, 2022 , approximately 43% of the deposits received in 2022 for our annuity products were ceded to reinsurance vehicles capitalized by third party reinsurers or held in protected cells within Seneca Re for future reinsurance transactions. We operate our core business through four subsidiaries under one reportable segment.American Life & Security Corp. ("American Life") is aNebraska -domiciled life insurance company, currently licensed to sell, underwrite, and market life insurance and annuity products in 24 states and theDistrict of Columbia . American Life obtained a financial strength rating of B++ ("Good") fromA.M. Best Company ("A.M. Best"), a leading rating agency for insurance companies, inDecember 2018 . That rating was affirmed inMarch 2023 whenA.M. Best also revised its outlook for American Life from Positive to Stable. All of our annuities are written by American Life. Our other insurance subsidiary, Seneca Re, is aVermont -domiciled sponsored captive reinsurance company established in early 2020 to reinsure various types of risks on behalf of American Life and third-party capital providers through special purpose reinsurance entities known as "protected cells." Through Seneca Re, we assist capital market investors in establishing and licensing new protected cells.
Our fourth subsidiary, 1505 Capital, is anSEC registered investment adviser providing financial, investment advisory, and management services. Our asset management services are available to third-party insurers and reinsurers. AtDecember 31, 2022 , 1505 Capital had approximately$501.9 million total third-party assets under management. We seek to deliver long-term value by growing our annuity volumes and generating profitable fee-based revenue. We generate fees and other revenue based on the gross deposits received on the annuity policies we issue, reinsure, and administer. We provide an end-to-end solution to manage annuity products that includes a broad set of product development, distribution support, policy administration, and asset/liability management services. Our platform enables us to efficiently develop, sell and administer a wide range of annuity products. 37 Table of Contents
Industry Trends and Market Conditions
Market
We participate in a large U.S. market that we expect to grow in part due to a number of demographic trends. As measured by annual premiums written, annuities are the largest product line in the life, annuity, and accident and health sector. Annuities play an important role in retirement planning by providing individuals with stable, tax-efficient sources of income. In 2021, annuity premiums accounted for$319 billion of annual premiums, or approximately 30% of the$1.1 trillion of total annual life, annuity, and accident and health premiums according to theInsurance Information Institute . The most common annuities are fixed and variable and can be written on an individual or group basis. Our current products are MYGAs and FIAs written on an individual basis. An increasing portion of theU.S. population is of retirement age and is expected to increase the retirement income needs of retirees. The number of people of retirement age has increased significantly since 2010, driven by the aging of the "Baby Boomer" generation. TheU.S. population over 65 years old is forecasted to grow from 56 million in 2020 to an estimated 81 million by 2040, according to theU.S. Census Bureau , Population Estimates and Projections. This study also forecasted thatU.S. population aged over 65 years old is expected to grow by 44% from 2020 to 2040, while the totalU.S. population is expected to grow by only 12%. Annuities in theU.S. are distributed through a number of channels, most of which are independent from the insurance companies that issue annuities. Independent distribution channels serve as the primary and a growing source of annuity distribution. In 2021, approximately 77% ofU.S. individual annuity sales occurred through independent distributors, including independent agents, broker-dealers, and banks, representing an increase from approximately 70% in 2017 according toU.S. Individual Annuities, 2021 Year in Review,Life Insurance Marketing and Research Association ("LIMRA"), 2022. Independent agents are the second largest distribution channel, behind independent broker-dealers, accounting for approximately 19% ofU.S. individual annuity sales in 2021. IMOs provide independent agents with access to annuity products along with operational support services and functionality to support the distribution services of the agents. The infrastructure and support services provided by IMOs to independent agents are critical to the success of independent agents and their ability to serve their customers and generate additional sales. We believe that capital markets investors have been actively seeking investing in and acquiring insurance and reinsurance companies in recent years. Fixed annuities provide upfront premiums and stable, long-term payment obligations and are thus attractive sources of liability-funded assets for a variety of traditional and alternative asset managers and investors. However, there are significant regulatory and operational hurdles for capital providers looking to enter the insurance market. These hurdles are exacerbated by the limited legacy administrative capabilities, product development processes and technology systems, of traditional insurers and reinsurers. We provide asset managers and investors the ability to seamlessly access funding from annuities through a variety of reinsurance entities that we can form quickly and operate efficiently with lower upfront and ongoing regulatory and operating costs. State expansion efforts have taken more time than anticipated, as state insurance regulators would like to see a more fully developed historical financial footprint. We are working diligently to file in more states, responding and providing increased information to regulators and discussing how our business model ensures policyholders are protected, given the capital held and supported by the use of reinsurance. We currently distribute annuity products through 27 third-party IMOs. We believe our product development, prompt policy processing, operating flexibility and speed to market make us a desirable partner for insurance distributors. We are seeking to grow by increasing volumes with our current IMOs and by establishing new IMO relationships. Competition We operate in highly competitive markets with a variety of participants, including insurance companies, financial institutions, asset managers, and reinsurance companies. These companies compete in various forms in the annuity market, for investment assets and for services. We seek to build strong relationships along with offering technology-enabled and services-oriented solutions for our partners. Our experience indicates that the market for annuities is dynamic. The combination of the treasury market experiencing the unprecedented rate increases and the volatility in the market resulting from the war inUkraine and related economic uncertainties due to inflation has opened up investment opportunities that allow us, and our reinsurance partners, to support more competitive rates for annuities. Based on our experience with COVID, we expect this investment environment to be conducive to our business model. We have been reviewing policy pricing along with reinsurer appetite to ensure we continue to grow our business while managing risk. We have recently taken pricing action on both our FIA and MYGA products and continue to monitor our competitiveness in the market. 38
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We have also increased our focus on marketing, reestablishing, and expanding our relationships on the distribution side through various channels and are reallocating or adding resources relating to this initiative. As a result, we experienced encouraging sales as 2022 unfolded. However, we expect competition in our market to remain intense particularly from other well established entities providing annuity products.
Interest Rate Environment
TheFederal Reserve has continued increasing short-term interest rates, compared to the historically low levels in 2021 and the expectation communicated fromU.S. federal banking officials is for rate increases to continue. We seek to address our interest rate risk through managing the duration of the liabilities and purchasing and holding quality, long-term assets mirroring that duration.
If interest rates were to rise, we believe the yield on our floating rate investments and the yield on new investment purchases would rise. We also believe our products would therefore be more attractive to consumers and our annuities sales would increase.
Discontinuation of LIBOR
The Financial Conduct Authority ("FCA"), theUnited Kingdom regulator of the London Interbank Offered Rate ("LIBOR"), previously indicated that it intends to stop compelling panel banks to submit quotes used to determine LIBOR after 2021. OnNovember 30, 2020 , the Intercontinental Exchange ("ICE")Benchmark Administration ("IBA"), the administrator of LIBOR, announced a consultation regarding its intention to cease the publication of one week and two-monthU.S. Dollar LIBOR settings at the end ofDecember 2021 , but to extend the publication of the remainingU.S. Dollar LIBOR settings (overnight and one, three, six, and 12-monthU.S. Dollar LIBOR) until the end ofJune 2023 . The IBA intends to share the results of the consultation with theFCA and publish a summary of the responses.U.S. bank regulators acknowledged the announcement and, subject to certain limited exceptions, advised banks to cease writing newU.S. Dollar LIBOR contracts by the end of 2021. We are in the process of analyzing and identifying our securities, financial instruments, and contracts that utilize LIBOR (collectively "LIBOR Instruments") to determine if we have any material exposure to the transition from LIBOR. To the extent we hold LIBOR Instruments, the terms of these instruments may have fallback provisions that provide for an alternative reference rate when LIBOR ceases to exist. For securities without adequate fallback provisions already in place, federal legislation has been enacted to provide a safe harbor for transition to the recommended alternative reference rate. Notwithstanding the availability of statutory guidance on fallback procedures, in preparation for the phase out of LIBOR, we may need to renegotiate our LIBOR Instruments that utilize LIBOR. However, these efforts may not be successful in mitigating the legal and financial risk from changing the reference rate in our LIBOR Instruments. Furthermore, the discontinuation of LIBOR may adversely impact our ability to manage and hedge exposures to fluctuations in interest rates using derivative instruments. As a result, the transition of our LIBOR Instruments to alternative reference rates, including the Secured Overnight Financing Rate ("SOFR"), may result in adverse changes to the net investment income, fair market value and return on those investments. We in-tend to continue evaluating and monitoring the risks associated with the LIBOR transition which include identifying and monitoring our exposure to LIBOR and ensuring operational processes are updated to accommodate alternative rates. Due to uncertainty surrounding the effect of adopting or transitioning to alternative rates such as SOFR, we are unable to predict the overall impact of this change at this time.
Critical Accounting Policies and Estimates
Our accounting and reporting policies are in accordance with GAAP. Preparation of our Consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The following is a summary of our significant accounting policies and estimates. These accounting policies inherently require significant judgment and assumptions, and actual operating results could differ significantly from management's estimates determined using these policies. We believe the following accounting policies, judgments, and estimates are the most critical to the understanding of our results of operations and financial position. Our accounting policies, judgments, and estimates have not changed significantly over our disclosed accounting periods. For further discussion of our accounting policies and estimates see "Note 1 - Nature of Operations and Summary of Significant Accounting Policies" to our Consolidated financial statements.
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Valuation of Investments
All fixed maturities owned by the Company are considered available-for-sale and are included in the Consolidated financial statements at their fair value as of the financial statement date. Premiums and discounts on fixed maturity debt instruments are amortized using the scientific-yield method over the term of the bonds. Realized gains and losses on securities sold during the year are determined using the specific identification method. Unrealized holding gains and losses, net of applicable income taxes, are included in accumulated other comprehensive income. Declines in the fair value of available-for-sale securities below their amortized cost are evaluated to assess whether any other-than-temporary impairment loss should be recorded. In determining if these losses are expected to be other-than-temporary, the Company considers severity of impairment, duration of impairment, forecasted recovery period, issuer credit ratings, and the intent and ability of the Company to hold the investment until the recovery of the cost. The recognition of other-than-temporary impairment losses on debt securities is dependent on the facts and circumstances related to the specific security. If the Company intends to sell a security or it is more likely than not that the Company would be required to sell a security prior to recovery of the amortized cost, the difference between amortized cost and fair value is recognized in the statement of comprehensive income as an impairment. If the Company does not expect to recover the amortized basis, does not plan to sell the security, and if it is not more likely than not that the Company would be required to sell a security before the recovery of its amortized cost, the recognition of the impairment is bifurcated. The Company recognizes the credit loss portion as realized losses and the noncredit loss portion in accumulated other comprehensive loss. The credit component of other-than-temporary impairment is determined by comparing the net present value of projected cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting the Company's best estimate of projected future cash flows at the effective interest rate implicit in the fixed income security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default. As ofDecember 31, 2020 , the Company analyzed its securities portfolio and determined that an impairment of approximately$35,000 should be recorded for one debt security, an impairment of$500,000 was recognized on a preferred stock, and a valuation allowance of$777,000 established on one lease. The valuation allowance on the lease of$777,000 was released as ofMarch 31, 2021 due to the sale of the investment. As ofDecember 31, 2022 , the Company held one asset valued at$7.7 million with a total impairment of$1.4 million . No such impairments were recognized as ofDecember 31, 2021 .
Investment income consists of interest, dividends, gains and losses, and real estate income, which are recognized on an accrual basis along with the amortization of premiums and discounts.
Certain available-for-sale investments are maintained as collateral under funds
withheld ("FW") and modified coinsurance ("Modco") agreements but the assets and
total returns or losses on the asset portfolios belong to the third-party
reinsurers. American Life has treaties with several third-party reinsurers that
have FW and Modco provisions. In a Modco agreement, the ceding entity retains
the assets equal to the modified coinsurance reserves retained. In a FW
agreement, assets that would normally be paid over to a reinsurer are withheld
by the ceding company to permit statutory credit for unauthorized reinsurers to
reduce the potential credit risk. The unrealized gains/losses on those
investments are passed through to the third-party reinsurers, through the fair
value of our total return swap, as either a realized gain or loss on the
Consolidated Statements of Comprehensive Loss.
Intangibles
We assess the recoverability of indefinite-lived intangible assets at least annually or whenever events or circumstances suggest that the carrying value of an identifiable indefinite-lived intangible asset may exceed the sum of the future discounted cash flows expected to result from its use and eventual disposition. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. Our indefinite-lived intangible assets consist of American Life's state licenses. We compared the carrying value to the current costs of obtaining licenses in those states. As ofDecember 31, 2022 , the sum of the fair value of those licenses exceeded the carrying value of the indefinite-lived intangible assets. These amounts are carried on our balance sheet in Other Assets. 40 Table of Contents Reinsurance We expect to reinsure most of the risks associated with our issued annuities. Our reinsurers may be domestic, foreign or capital markets investors seeking to assumeU.S. insurance business. In most reinsurance transactions, American Life will remain exposed to the credit risk of reinsurers, or the risk that one or more reinsurers may become insolvent or otherwise unable or unwilling to pay for policyholder claims. We seek to mitigate the credit risk relating to reinsurers by generally either requiring that the reinsurer post substantial collateral or make other financial commitments as a security for the reinsured risks. Under these reinsurance agreements, there typically is a monthly or quarterly settlement of premiums, claims, surrenders, collateral, and other administration fees. In a typical reinsurance transaction, we receive a ceding commission and reimbursement of certain expenses at the time liabilities are reinsured, plus ongoing fees for the administration of the business ceded. Our reinsurers are typically not "accredited" or qualified as reinsurers underNebraska law. In order to receive credit for reinsurance for transactions with these reinsurers and to reduce potential credit risk, we usually hold collateral from the reinsurer on a FW basis or require the reinsurer to maintain a trust that holds assets backing up its obligation to pay claims on the business it assumes. In some cases, the reinsurer may appoint an investment manager to manage these assets pursuant to guidelines approved by us that are consistent with state investment statutes and regulations relating to reinsurance. When our investment advisor subsidiary, 1505 Capital, is appointed to manage these assets, we receive additional ongoing asset management fees.
Future Policy Benefits
We establish liabilities for amounts payable under our policies, including annuities. Generally, amounts are payable over an extended period of time. Under GAAP, our annuities are treated as deposit liabilities, where we use account value in lieu of future policy reserves. Our FIA reserves are calculated by an independent consulting actuary and our MYGA reserves equal the account value from our policy administration system. We currently do not offer traditional life insurance products. Income Taxes Deferred tax assets are recorded based on the differences between the financial statement and tax basis of assets and liabilities at the applicable tax rates. The principal assets and liabilities giving rise to these differences are investments, insurance reserves, and deferred acquisition costs. A deferred tax asset valuation allowance is established when there is uncertainty that such tax assets would be realized. We have no uncertain tax positions that we believe are more-likely-than not that the benefit will not be realized.
Recognition of Revenues
Amounts received as payment for annuities are recognized as deposits to
policyholder account balances and included deposit-type contract liabilities.
Annuity premiums are shown as a financing activity in the Consolidated
Statements of Cash Flows. Revenues from these contracts are comprised of fees
earned for administrative and policyholder services, which are recognized over
the period of the annuity contracts and included in other revenue. Through our
reinsurance contracts, revenues are earned through ceding commissions, which are
capitalized, and our independent consulting actuary determines the amounts to be
recognized as income over the period of the annuity contracts. Deferred
coinsurance ceding commissions are shown as an operating activity in the
Consolidated Statements of Cash Flows. Revenues from asset management services
are recognized as earned.
Derivative Instruments
Derivatives are used to hedge the risks experienced in our ongoing operations,
such as equity, interest rate, and cash flow risks, or for other risk management
purposes, which primarily involve managing liability risks associated with our
FIA product and reinsurance agreements. Derivatives are financial instruments
whose values are derived from interest rates, foreign exchange rates, financial
indices, or other underlying notional amounts. Derivative assets and liabilities
are carried at fair value on the Consolidated Balance Sheets.
To qualify for hedge accounting, at the inception of the hedging relationship,
we formally document our designation of the hedge as a cash flow or fair value
hedge and our risk management objective and strategy for undertaking the hedging
transaction identifying how the hedging instrument is expected to hedge the
designated risks related to the hedged item, the method to retrospectively, and
prospectively assess the hedging instrument's effectiveness and the method to be
used to measure ineffectiveness. A derivative
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designated as a hedging instrument must be assessed as being highly effective in offsetting the designated risk of the hedged item. Hedge effectiveness is also assessed periodically throughout the life of the designated hedging relationship. In late 2019, we began investing in options to hedge our interest rate risks on our FIA product. Options typically do not qualify for hedge accounting; therefore, we chose not to use hedge accounting for the related options that we currently have. We value our derivatives at fair market value with the offset being recorded on our Consolidated Statements of Comprehensive Loss as a realized gain or (loss).
Additionally, reinsurance agreements written on a FW basis contain embedded derivatives on our FIA product. Gains or (losses) associated with the performance of assets maintained in the relevant deposit and funds withheld accounts are reflected as realized gains or (losses) in our Consolidated Statements of Comprehensive Loss.
Derivatives
The Company has entered into certain derivative instruments to hedge FIA products that guarantee the return of principal to our policyholders and credit interest based on a percentage of the gain in a specified market index. To hedge against adverse changes in equity indices, the Company entered into contracts to buy equity indexed options. The change in fair value of the derivatives for hedging the FIA index credits and the related embedded derivative liability fluctuate from period to period based on the change in the market interest rates. The indexed reserves are measured at fair value for the current period and future periods. We hedge with options that align with the terms of our FIA products which are between seven and ten years. We have analyzed our hedging strategy on our FIA products and, while the correlation of the hedges to the FIA products is not matched dollar for dollar, we believe the hedges are effective
as of
American Life also has agreements with several third-party reinsurers that have FW andModco provisions under which the assets related to the reinsured business are maintained by American Life as collateral; however, ownership of the assets and the total return on the asset portfolios belong to the third-party reinsurers. Under GAAP, this arrangement is considered an embedded derivative as discussed in "Note 4 - Derivative Instruments" to our Consolidated financial statements. Assets carried as investments on American Life's financial statements for the third-party reinsurers contained cumulative unrealized losses as ofDecember 31, 2022 and cumulative unrealized gains as ofDecember 31, 2021 , of approximately$10.5 million and$0.2 million , respectively. The terms of the contracts with the third-party reinsurers provide that the changes in unrealized gains and losses on the portfolios accrue to the third-party reinsurers. We account for these unrealized gains by recording equivalent realized gains or losses on our Consolidated Statements of Comprehensive Loss. Accordingly, the unrealized gains on the assets held by American Life on behalf of the third-party reinsurers were offset by recording an embedded derivative gain of$10.6 million and loss of$2.8 million as ofDecember 31, 2022 and 2021, respectively. If prices of investments fluctuate, the unrealized gains or losses of the third-party reinsurers may also fluctuate; therefore, the associated embedded derivative gain (loss) recognized by us would be increased or decreased accordingly. Net Income (Loss)
In this section, unless otherwise noted the discussion below compares the year
ended
We incurred a comprehensive loss of$46.9 million including unrealized loss of$54.0 million , mainly from the fixed maturity portfolio, resulting in net income to Midwest of$7.1 million for the year endedDecember 31, 2022 . This compares to a comprehensive loss of$20.4 million including unrealized loss of$3.8 million , resulting in net loss of$16.6 million to Midwest last year. Overall, revenues were flat year over year being impacted by realized losses of$14.9 million for the year endedDecember 31, 2022 versus a gain of$7.8 million in the prior year. Investment income increased due to the growth in the retained portfolio and from higher interest rates. Policy administration fees were up due to the increase in deposit liabilities through annuity premiums written in 2022 of$715.8 million versus$471.6 million in the prior year. Amortization of deferred ceded premium grew as we added new reinsurers and the portfolio continues to age. Service fee revenue was consistent with prior years as AUM was$502 million versus$405 million in the prior year. 42
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Overall, expenses were down, driven by negative interest credited and benefitting from the option allowance (see point 3 below). Controllable expenses increased 42% from$41.3 million to$58.8 million compared to 62% growth in deposit liabilities through annuity premiums written for the year. Salaries and benefits increased (after the exclusion of a one-time accelerated vesting of stock options) with additional personnel, repositioning and retaining of personnel to support growth and given tight labor market. Increase in Other expenses was driven by consulting, legal and accounting fees to support distribution, state expansion, and capital initiatives, along with technology initiatives. The effective tax rate was 90.6% compared to 40.1% for the year endedDecember 31, 2022 and 2021, respectively. Our primary insurance entities, American Life, SRC1, and SRC3, are taxed on a statutory basis. GAAP defers the recognition of income related to premiums received until they are earned across the life of the contract. Statutory principles though recognize premiums as income in the period they are received, creating the difference between the two statements of income. See Note 9 to our financial statements for further information related to the income tax expense.
Our FIA products have three components influencing our Consolidated Statements of Comprehensive Loss:
The embedded derivative in our FIAs. We carry this derivative at fair value,
with the change in fair value recorded in the interest credited line of our
Consolidated Statements of Comprehensive Loss. Across our FIA products,
1) interest credited was negative
of the embedded derivative corresponds to the change in the value of option
contracts we use to hedge this exposure.
The derivatives we purchase to hedge stock market risk we would otherwise face
from our FIA. We carry these derivatives at fair value on our balance sheet,
2) recording the change in fair value in our Consolidated Statements of
Comprehensive Loss as either a realized gain or realized loss. In 2022, the
market value of the derivative assets was
million in 2021 in our net unrealized gain on investments.
The option budget reinsurers pay us to purchase derivative assets. We mark
these assets to market each period. Separately, we record a payable to the
reinsurers that is owed to a reinsurer when a policy is surrendered, an
annuitant dies, or a policy lapses. We compare what the reinsurer paid for the
3) original option budget to the market value at the end of the period. The
change in the market value is added to or subtracted from the payable to the
reinsurer to cover the reinsurer's obligations to the policyholder. This
change in market value resulted in a negative
included in our other operating expense in 2022 compared to a
expense in the prior year.
American Life has treaties with several third-party reinsurers that have funds withheld and modified coinsurance provisions. As a result of changes in interest rates, assets held on behalf of the third-party reinsurers had unrealized losses of approximately$10.5 million and gains of$0.2 million atDecember 31, 2022 and 2021, respectively. The terms of the contracts with the third-party reinsurers provide that unrealized gains or losses on the asset portfolio accrue to the reinsurers. We account for the change in these unrealized gains or losses by recording equivalent realized gains or losses on our Consolidated Statements of Comprehensive Loss. We recorded the decrease in the unrealized gains as a realized gain of$10.6 million in 2022 compared to a realized loss of$2.8
million in 2021.
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Consolidated Results of Operations - Years Ended
Revenues
The following summarizes the sources of our revenue:
Year ended December 31,
(In thousands) 2022 2021
Premiums $ - $ -
Investment income, net of expenses 35,115 $ 15,737 Net realized (losses) gains on investments (14,878) 7,752 Amortization of deferred gain on reinsurance
4,816 3,022
Policy administration fees 2,130 842
Service fee revenue, net of expenses 2,366 2,343
Other revenue 500 367
$ 30,049 $ 30,063
Premium revenue: Sales of our MYGA and FIA products generated a large volume of
new business in 2022 and 2021; however, these products are defined as investment
contracts under GAAP. Accordingly the funds we received from our customers under
these contracts were recorded on our balance sheet as a deposit-type liability -
and not as premium revenue.
Investment income, net of expenses: The components of net investment income for 2022 and 2021 were as follows:
Year ended December 31,
(In thousands) 2022 2021
Fixed maturities $ 38,299 $ 16,443
Mortgage loans 2,456 185
Other invested assets 1,854 665
Other interest (expense) income (1,517) 298
Gross investment income 41,092 17,591
Less: investment expenses (5,977) (1,854)
Investment income, net of expenses
Investment income, net of expenses consisted of investment income generated from our retained investment assets that are not ceded to reinsurers. The increase was due to the investment income earned on our bonds and mortgage loans purchased with the sales of our MYGA and FIA products that were not ceded to reinsurers during the period, as well as deployment of excess cash towards credit investments with attractive yields and risk-return profiles. As ofDecember 31, 2022 and 2021, on a gross consolidated basis, our investment portfolio (excluding cash) was$1,615.0 million and$975.5 million , respectively, as a result of proceeds from our MYGA and FIA product sales, reflecting both retained premium proceeds as well as assets held on behalf of our reinsurers. Net realized losses on investments: Net realized losses on investments were$14.9 million in 2022 compared with gains of$7.8 million in 2021. The figures include a gain of$10.6 million and a loss of$2.8 million from a total return swap embedded derivative in 2022 and 2021, respectively. In 2022, there were net realized losses of$14.5 million related to derivatives we own to hedge the obligations to FIA policyholders; such losses were partially offset by an increase in the mark-to-market change in embedded derivative liability within interest credited expense and an increase in FIA-related mark-to-market option allowance expense flowing through other operating expenses. The change in fair value of FIA hedging derivatives is driven by the performance of the indices upon which our call options are based. American Life has treaties with several reinsurers that have funds withheld coinsurance provisions, under which the assets backing the treaties are maintained by American Life as collateral but the assets and total return on the asset portfolios belong to the reinsurers. Under GAAP this arrangement is considered an embedded derivative as discussed in Note 4 - Derivative Instruments to our Consolidated financial statements. The change in fair value of the total return swap is included in net realized gains or losses on investments. Assets carried as investments on American Life's financial statements for the third-party reinsurers contained unrealized losses of approximately$10.5 million and gains of approximately$0.2 million for the years endedDecember 31, 2022 and 2021, 44
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respectively. The terms of the contracts with the third-party reinsurers provide that unrealized gains or losses on the portfolios accrue to the third-party reinsurers. We recorded the unrealized gains and losses accruing to third-party reinsurers via a total return swap resulting in a realized gain of$10.6 million and a realized loss of$2.8 million in 2022 and 2021, respectively.
Amortization of deferred gain on reinsurance: The increase in 2022 to
Policy administration fees: Policy administration fees includes fees received for the servicing and initiation of policies ceded to our reinsurers. Also included are fees surrendered by policy holders for early termination of their contracts. The increase of revenue to$2.1 million in 2022 from$0.8 million in 2021 was driven primarily by the increase in policies written and ceded, as well as additional policy holder early termination. Service fee revenue, net of expenses: Service fee revenue, net of expenses, consists of fee revenue generated by 1505 Capital, for asset management services provided to third-party clients, some of whom are our reinsurers. The increase in this revenue, to$2.4 million in 2022 from$2.3 million in 2021, was due primarily to the level of asset management services provided by 1505 Capital to third-party clients.
Other revenue: Other revenue consists of revenue generated by us for providing administrative services for clients.
Expenses
Our expenses for the periods indicated are summarized in the table below:
Year ended December 31,
(In thousands) 2022 2021
Interest credited $ (10,193) $ 7,012
Benefits 3,206 6
Amortization of deferred acquisition costs 4,788 2,886
Salaries and benefits 16,196 16,926
Other operating expenses 7,661 15,104
$ 21,658 $ 41,934 Interest credited: The decrease was primarily due to the interest credited across all our products in 2022. Interest credited for our retained MYGA products was positive$7.2 million while interest credited related to our retained FIA policies was negative$17.2 million in 2022. MYGA and FIA interest credited were positive$2.8 million and$4.2 million for 2021, respectively. The FIA interest credited is related to the fair market value of the embedded derivative which is owed to policyholders. This was partially offset by the realized gain on our total return swap that is included in the net realized gain on investment above.
Benefits: This refers to death benefits on our policies, which saw an increase
to
Amortization of deferred acquisition costs: The increase was due to the acquisition costs relating to the sale of American Life's MYGA and FIA products where we retained approximately 57% of the business in 2022 compared to the 50% retained in 2021. These figures include the Seneca Re protected cells, SRC1 and SRC3, and DAC amortization. Salaries and benefits The slight decrease to$16.2 million compared with$16.9 million was due to changes in upper management, offset by continued costs incurred to attract and add personnel to service our business growth combined with significantly lower costs related to non-cash stock consideration. We are hiring more in-house expertise to service our growth initiatives and reduce the reliance on third-party providers.
Other operating expenses: Other operating expenses were approximately
Our FIA product has embedded derivatives included in the account value. Those
? derivatives are market driven. The reinsurers that reinsure the FIA products
pay an option allowance to American Life to purchase derivatives. As ofDecember 31, 2022 , 45 Table of Contents
the mark-to-market adjustment on those allowances was in a positive position so
American Life incurred a negative
reinsurers for that mark-up. As the market fluctuates going forward, the mark up
of the option allowance could go up or down.
Increases of other expenses related to legal and consulting fees of
? million related primarily to efforts to secure new additional capital sources
and the expansion of our business into new jurisdictions.
Taxes
Income tax expense increased by
Investments
Most investments on our Consolidated balance sheets are held on behalf of our reinsurers as collateral under our reinsurance agreements. As a result, our investment allocations are largely a function of our collective reinsurer investment allocations. While the reinsurers own the investment risk on these assets, we typically restrict their investment allocations via control over the selection of the asset manager as well as asset restrictions set forth in investment guidelines and control over the investment manager. In many of our reinsurance agreements, 1505 Capital acts as the asset manager for a fee. Our investment guidelines typically includeU.S. government bonds, corporate bonds, commercial mortgages, asset backed securities, municipal bonds, and collateral loans. The duration of our investments is 5 to 10 years in line with that of our liabilities. We do allow non-U.S. dollar denominated investments where the foreign exchange risk is hedged back toU.S. dollars. 46
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The following table shows the carrying value of our investments by investment category and cash and cash equivalents, and the percentage of each to total invested assets as ofDecember 31, 2022 and 2021. Increases in fixed maturity securities primarily resulted from the sale of our MYGA and FIA products during 2022. December 31, 2022 December 31, 2021 Carrying Percent Carrying Percent (In thousands) Value of Total Value of Total Fixed maturity securities: Bonds: U.S. government obligations$ 1,262 0.1 %$ 1,882 0.2 % Mortgage-backed securities 294,066 16.3 55,280 4.9 Asset-backed securities 30,756 1.7 24,951 2.2 Collateralized loan obligations 287,673 15.9 274,523 24.6 States and political subdivisions-general obligations 101 -
114 - States and political subdivisions-special revenue 205 - 5,612 0.5 Corporate 41,600 2.3 37,139 3.3 Term loans 558,972 30.9 267,468 23.9 Trust preferred - - 2,237 0.2 Redeemable preferred stock - - 14,090 1.3 Total fixed maturity securities 1,214,635 67.2 683,296 61.1 Mortgage loans on real estate, held for investment 227,047 12.6 183,203 16.4 Derivatives 15,934 0.9 23,022 2.1 Equity securities 5,111 0.3 21,869 2.0 Other invested assets 112,431 6.2 35,293 3.2 Investment escrow 784 - 3,611 0.3
Federal Home Loan Bank stock 1,306 0.2
500 - Preferred stock 31,415 1.7 18,686 1.7 Notes receivable 6,269 0.3 5,960 0.5 Policy Loans 25 - 87 - Cash and cash equivalents 191,414 10.6 142,013 12.7 Total investments, including cash and cash equivalents$ 1,806,371 100.0 % $
1,117,540 100.0 %
The following table shows the distribution of the credit ratings of our portfolio of fixed maturity securities by carrying value as ofDecember 31, 2022 and 2021. December 31, 2022 December 31, 2021 Carrying Carrying (In thousands) Value Percent Value Percent AAA and U.S. Government$ 124,183 10.2 %$ 2,674 0.4 % AA 815 0.1 482 0.1 A 371,371 30.6 168,141 24.6 BBB 619,516 51.0 462,699 67.7 Total investment grade 1,115,885 91.9 633,996 92.8 BB and below 98,750 8.1 49,300 7.2 Total$ 1,214,635 100.0 %$ 683,296 100.0 %
Reflecting the quality of securities maintained by us, 91.9% and 92.8% of all
fixed maturity securities were investment grade as of
We expect that our MYGA and FIA products sales will result in an increase in investable assets in future periods.
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Market Risks of Financial Instruments
The primary market risks affecting the investment portfolio are interest rate risk, credit risk, and liquidity risk. With respect to investments that we hold on our balance sheet as collateral, our reinsurers bear the market risks related to these investments, while we bear the market risks on any net retained investments.
Interest Rate Risk
Interest rate risk arises from the price sensitivity of investments to changes in interest rates. Interest and dividend income represent the greatest portion of an investment's return for most fixed maturity securities in stable interest rate environments. The changes in the fair value of such investments are inversely related to changes in market interest rates. As interest rates fall, the interest and dividend streams of existing fixed-rate investments become more valuable and fair values rise. As interest rates rise, the opposite effect occurs. Our liabilities also have interest rate risk though GAAP does not require our liabilities to be marked to market. We mitigate interest rate risk by monitoring and matching the duration of assets compared to the duration
of liabilities. Credit Risk We are exposed to credit risk through counterparties and within the investment portfolio. Credit risk relates to the uncertainty associated with an obligor's ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. We manage our credit risk through diversification of investments amongst many corporations and numerous industries. Additionally, our investment policy limits the size of holding
in any particular issuer. Liquidity Risk
We are exposed to liquidity risk when liabilities come due. In order to pay a policyholder, we may need to liquidate assets. If our assets are illiquid assets, we might be unable to convert an asset into cash without giving up capital and income due to a lack of buyers or an inefficient market. We seek to mitigate this risk by keeping a portion of our investment portfolio in liquid investments.
Statutory Accounting and Regulations
Our primary insurance subsidiary, American Life, is required to prepare statutory financial statements in accordance with SAP prescribed by the NDOI. SAP primarily differs from GAAP by charging policy acquisition costs to expense as incurred, establishing future benefit liabilities using actuarial assumptions as well as valuing investments and certain assets and accounting for deferred taxes on a different basis. For further discussion regarding SAP as well as net income (loss) of American Life under SAP, see Note 13 to our consolidated financial statements. As ofDecember 31, 2022 , American Life maintained sufficient capital and surplus to comply with regulatory requirements. State insurance laws and regulations govern the operations of all insurers and reinsurers such as our insurance and reinsurance company subsidiaries. These various laws and regulations require that insurance companies maintain minimum amounts of statutory surplus as regards policyholders and risk-based capital and determine the dividends that insurers can pay without prior approval from regulators. The statutory net income of American Life is one of the primary sources of additions to our statutory surplus as regards policyholders, in addition to capital contributions from us. We have reported our insurance subsidiaries' assets, liabilities and results of operations in accordance with GAAP, which varies from SAP. The following items are principal differences between SAP and GAAP. SAP:
? requires that we exclude certain assets, called non-admitted assets, from the
balance sheet.
requires us to expense policy acquisition costs when incurred, while GAAP
? allows us to defer and amortize policy acquisition costs over the estimated
life of the policies.
? dictates how much of a deferred income tax asset that we can admit on a
statutory balance sheet.
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requires that we record certain investments at cost or amortized cost, while we
? record other investments at fair value; however, GAAP requires that we record
all investments at fair value.
allows bonds to be carried at amortized cost or fair value based on the rating
? received from the
recorded at fair value for GAAP.
allows ceding commission income to be recognized when written if the cost of
? acquiring and renewing the associated business exceeds the ceding commissions,
but under GAAP such income is deferred and recognized over the coverage period.
requires that we record reserves in liabilities and expense for policies
? written, while we record all transactions related to the annuity products under
GAAP as deposit-type contract liabilities.
requires a provision for reinsurance liability be established for reinsurance
recoverable on paid losses aged over 90 days and for unsecured amounts
? recoverable from unauthorized reinsurers. Under GAAP there is no charge for
uncollateralized amounts ceded to a company not licensed in the insurance
affiliate's domiciliary state and a reserve for uncollectable reinsurance is
charged through earnings rather than surplus or equity.
requires an additional admissibility test outlined in Statements on Statutory
Accounting Principles, No. 101 and the change in deferred income tax is
reported directly in capital and surplus, rather than being reported as a
? component of income tax expense under GAAP. Our insurance subsidiaries must
file with the insurance regulatory authorities an "Annual Statement" which
reports, among other items, net income (loss) and surplus as regards
policyholders, which is called stockholders' equity under GAAP.
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The table below sets forth our SAP net income (loss) for 2022 and 2021 for each of our insurance subsidiaries and then reconciled to GAAP.
Year ended December 31,
(In thousands) 2022 2021
Consolidated GAAP net income (loss) $ 7,140 $ (16,637) Exclude: Midwest non-insurance transaction entities (American Life & Seneca Re)
6,680 (6,961)
GAAP net gain (loss) of statutory insurance entities $ 460 $ (9,676)
GAAP net income (loss) by statutory insurance entity:
American Life $ 12,459 $ (8,742)
Seneca Re Incorporated Cell 01 (10,426) (321)
Seneca Re Incorporated Cell 03 (1,573) (613)
GAAP net gain (loss) $ 460 $ (9,676)
Reconciliation of GAAP and SAP
GAAP net income (loss) of American Life
12,459 (8,742)
Increase (decrease) due to:
Deferred acquisition costs (36,003) (34,451)
Coinsurance transactions 435,413 171,687
Carrying value of reserves (405,565) (133,028)Foreign exchange and derivatives 35,025 - Gain (loss) on sale of investments, net of asset valuation reserve (33,935) (1,861) Other (5,064) 40 SAP net income (loss) of American Life $ 2,330 $ (6,355) GAAP net loss of Seneca Re Incorporated Cell 01
(10,426) (321)
Increase (decrease) due to:
Deferred acquisition costs 2,730 (3,343)
Coinsurance transactions 222 37,763
Carrying value of reserves (9,996) (36,995)Gain on sale of investments, net of asset valuation reserve 19,815 1,847 Other gain (loss) (1,146) 45 SAP net income (loss) of Seneca Re Incorporated Cell $ 1,199 $ (1,004) GAAP net loss of Seneca Re Incorporated Cell 03
(1,573) (613)
Increase (decrease) due to:
Deferred acquisition costs (3,649) (10,325)
Coinsurance transactions 35,773 88,704
Carrying value of reserves (37,717) (84,865)Gain on sale of investments, net of asset valuation reserve 8,633 282 Other (111) (34) SAP net income (loss) of Seneca Re Incorporated Cell 03 $ 1,356 $ (6,851) SAP net gain (loss) of statutory insurance entities $ 4,885$ (14,210)
Key Operating and Non-GAAP Measures
We discuss below non-GAAP financial measures that management uses in conjunction with GAAP financial measures as an integral part of managing our business and to, among other things:
• monitor and evaluate the performance of our business operations and financial performance;
• facilitate internal comparisons of the historical operating performance of our business operations;
• review and assess the operating performance of our management team;
• analyze and evaluate financial and strategic planning decisions regarding future operations; and
• plan for and prepare future annual operating budgets and determine appropriate levels of operating investments.
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Management believes the use of these non-GAAP measures, together with the relevant GAAP measures provides information that may enhance understanding of our results by investors. Non-GAAP financial measures used by us may be calculated differently from, and therefore may not be comparable to, similarly titled measures used by other companies. These non-GAAP financial measures should be considered along with, but not as alternatives to, our operating performance measures as prescribed by GAAP.
Operating Metric - Annuity Premiums
We monitor annuity premiums as a key operating metric in evaluating the
performance of our business. Annuity premiums, also referred to as sales or
direct written premiums, do not correspond to revenues under GAAP, but are
relevant metrics to understand our business performance. Under SAP, our annuity
premiums received are treated as premium revenue. Our premium metrics include
all sums paid into an individual annuity in a given period. We typically
transfer all or a substantial portion of the premium and policy obligations to
reinsurers. Ceded premium represents the premium we transfer to reinsurers in a
given period. Retained premium represents the portion of premium received during
a given period that was not ceded to reinsurers and will either be reinsured in
a subsequent period or retained by us. We typically retain premiums prior to
transferring them to reinsurers to facilitate block and other reinsurance
transactions involving portfolios of annuity premiums.
The following table sets forth premiums received under SAP. Under GAAP these
products are defined as deposit-type contracts; therefore, the premium revenue
is accounted under GAAP as deposit-type liabilities on our Consolidated balance
sheets and is not recognized in our Consolidated Statements of Comprehensive
Loss.
Year ended December 31,
(In thousands) 2022 2021
Annuity Premiums (SAP)
Annuity direct written premiums
(311,257) (237,411)
Net premiums retained $ 404,576 $ 234,235
The increase in annuity direct written premiums reflect strong sales throughout
2022, even in a challenging sales environment, in which competitors were pricing
rates on annuity products aggressively. We sell annuities through the IMO
channel. We aim to grow annuity direct written premiums by further developing
our relationships with existing IMOs and increasing the number of IMO partners
that distribute our annuity products, as well as increasing the number of states
in which we are licensed to sell our annuity products. We also aim to distribute
to new channels, including the registered investment advisor (RIA) channel as
well as the bank and broker-dealer channels. The increase in ceded premiums was
attributable primarily to the increase in annuity direct written premiums.Operating Metric - Fees Received for Reinsurance
Year ended December 31,
(In thousands) 2022 2021
Fees received for reinsurance(1)
Fees received for reinsurance - total $ 14,290 $ 13,412
(1) Consists of: 1) amortization of deferred gain on reinsurance, which is a
line item from our GAAP Consolidated Statements of Comprehensive Loss; and 2)
deferred coinsurance ceding commission, which is a line item from our GAAP
Consolidated Statements of Cash Flows.
For the year ended December 31, 2022 , fees received for reinsurance increased by
$0.9 million compared to the prior year period due to higher ceded premiums. For
the year ended December 31, 2022 , the components of fees received for
reinsurance included $4.8 million of amortization of deferred gain on
reinsurance from our Consolidated Statements of Comprehensive Loss and $9.5
million of deferred coinsurance ceding commission from our Consolidated
Statements of Cash Flows.
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Reconciliation - Management Expenses to GAAP Expenses
Year ended December 31,
2022 2021
Management Expenses
G&A $ 35,015 $ 24,632
Management interest credited 15,811 8,757Amortization of deferred acquisition costs 4,788
2,886
Expenses related to retained business 20,599
11,643 Management expenses - total$ 55,614 $ 36,275 Year ended December 31, 2022 2021 G&A Salaries and benefits - GAAP$ 16,196 $ 16,926
Other operating expenses - GAAP 7,661
15,104
Subtotal 23,857
32,030
Adjustments:
Less: Stock-based compensation (29)
(4,981)
Less: Mark-to-market option allowance 11,187
(2,417) G&A$ 35,015 $ 24,632 Year ended December 31, 2022 2021 Management Interest Credited Interest credited - GAAP$ (10,193) $ 7,012 Adjustments: Less: FIA interest credited - GAAP 17,171
(4,169)
Add: FIA options cost - amortized - GAAP 8,833
5,914
Management interest credited $ 15,811 $ 8,757
Year ended December 31,
2022 2021
Reconciliation - Management Expenses to GAAP Expenses
Total expenses - GAAP $ 21,658 $ 41,934
Adjustments:
Less: Benefits (3,206) (6)Less: Stock-based compensation (29)
(4,981)
Less: Mark-to-market option allowance 11,187
(2,417)
Less: FIA interest credited - GAAP 17,171
(4,169)
Add: FIA options cost - amortized - GAAP 8,833
5,914
Management expenses - total $ 55,614 $ 36,275 Operating Metric - Management and G&A Expenses
In addition to total expenses, we utilize management expenses as an economic measure to evaluate our financial performance. Management expenses consist of total GAAP expenses adjusted to eliminate items that fluctuate from quarter to quarter in a manner unrelated to core operations, which we believe are useful in analyzing operating trends. The most significant adjustments to arrive at management expenses include the use of management interest credited (as discussed below), the exclusion of stock-based compensation and the exclusion of the mark-to-market option allowance expense (included in other operating expenses) payable to reinsurers to cover their obligations under FIA policies we have reinsured with them. We believe the combined presentation and evaluation of total expenses together with management expenses provides information that can enhance an investor's understanding of our underlying operating results. For the year endedDecember 31, 2022 , GAAP general and administrative expenses totaled$35.0 million compared to$24.6 million for the prior year. For the year endedDecember 31, 2022 , as disclosed above, included in these expenses is
mainly salaries, benefits
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and other operating expenses, along with less than
Operating Metric - Management Interest Credited
We utilize management interest credited, a component of management expenses, as
an economic measure to evaluate our financial performance. GAAP interest
credited contains significant technical considerations related to fair value
accounting with respect to the mark-to-market change in the FIA embedded
derivative liability and change in actuarial valuation of the FIA reserve, both
of which are sensitive to changes in the market as well as changes in actuarial
assumptions. Due to these technical considerations that we believe are less
meaningful to management and investors, we exclude the GAAP interest credited
expense related to our FIA products and include the amortized cost of options we
purchase to service our FIA policy obligations. The sum of GAAP interest
credited related to our multi-year guaranteed annuity ("MYGA") products and the
amortized cost of options we purchase to service our FIA products constitutes
management interest credited.
For the year ended December 31, 2022 , GAAP interest credited totaled negative
$10.2 million compared to positive $ 7.0 million for the prior year. For the
year ended December 31, 2022 , as disclosed above, included in these expenses is
GAAP interest credited related to our retained FIA policies of approximately
negative $17.2 million .
Liquidity and Capital Resources
Investments
Information regarding our investment portfolio, which is comprised primarily of investment grade, fixed maturity securities, is presented in Part IV - Item 15, Exhibits and Financial Statement Schedules and in Part II - Item 8, Note 3 of the Consolidated Financial Statements in this report.
Comparative Cash Flows
AtDecember 31, 2022 and 2021, we had cash and cash equivalents totaling$191.4 and$142.0 million , respectively. Our short-term liquidity requirements, within a 12 month operating cycle, are for the timely payment of claims and benefits to policyholders, operating expenses, interest payments and federal income taxes. Cash flow generated from operations has been, and is expected to be, adequate to meet our operating cash needs in the next 12 months. Cash flow in excess of operational needs has been used to fund business growth. Long-term liquidity requirements, beyond one year, are principally for the payment of future insurance and annuity benefits. We believe that our existing cash and cash equivalents will be sufficient to fund our anticipated operating expenses and capital transaction expenditures for the foreseeable future. As our state expansion continues, we expect an increase in our sales of our MYGA and FIA products. However, our ability to continue to meet our future liquidity requirements will depend on, among other things, our ability to achieve anticipated levels of cash flows generated from operations and our ability to manage costs and working capital successfully, all of which are subject to general economic, financial, competitive and other factors beyond our control. In the event we require any additional capital, we may be required to raise additional funds, including through the sale of capital stock or debt in the public capital markets or in privately negotiated transactions, and there can be no assurance that we will be able to raise any such financing on terms acceptable to us or at all. If such funds are not available in the future, we may be required to delay or significantly modify our operations, each of which could have a material adverse impact on our results of operations or financial condition. For additional information, refer to Part I, Item 1A. Risk Factors-General Risks-Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs and access the capital required to operate our business. Cash flow is an important component of our business model because we receive annuity premiums and invest them upon receipt for our reinsurers and us and for the benefit of our policyholders. 53
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The following table summarizes our cash flows from operational, investing and
financing activities for the periods indicated. See the Consolidated Statements
of Cash Flow in our Consolidated financial statements for more detailed
information.
Year ended December 31,
2022 2021
(In thousands)
Net cash provided by (used in) operating activities $ 73,162 $ (25,338)
Net cash (used in) investing activities (708,708) (452,407)
Net cash provided by financing activities 684,947
468,079
Net increase (decrease) in cash and cash equivalents 49,401
(9,666) Cash and cash equivalents: Beginning of period 142,013 151,679 End of period$ 191,414 $ 142,013
Cash Provided by Operating Activities
Net cash provided by operating activities was$73.2 million for the year endedDecember 31, 2022 , which was comprised primarily of a decrease in receivable and payable for securities of$12.5 million , capitalized DAC of$23.9 million , net realized loss on investments of$14.9 million , accrued investment income of$11.5 million , and amounts recoverable from reinsurers of$29.0 million . These were offset by deposit-type liabilities of$3.4 million , and an increase in deferred coinsurance ceding commission to$9.5 million .
Cash Used in Investing Activities
Net cash used for investing activities for 2022 was$708.7 million . The primary source of cash used was from our purchase of investments from sales of the MYGA and FIA products of$1,258.3 million . Offsetting this use of cash was our sale of investments of$573.2 million .
Cash Flow Provided by Financing Activities
Net cash provided by financing activities in 2022 was
As ofDecember 31, 2022 , we held$198.1 million of cash,U.S. government and agency fixed maturity securities and public equity securities (excluding non-redeemable preferred stocks and foreign equity securities) which, under normal market conditions, could be rapidly liquidated. Certain remote events and circumstances could constrain our liquidity. Those events and circumstances include, for example, a catastrophe resulting in extraordinary losses, a downgrade of our Senior Notes rating to noninvestment grade status or a downgrade in our insurance subsidiaries' financial strength ratings. The rating agencies also consider the interdependence of our individually rated entities; therefore, a rating change in one entity could potentially affect the ratings of other related entities. Capital Resources
We have determined the amount of capital which is needed to adequately fund and support business growth, primarily based on risk-based capital formulas including those developed by the NAIC. Historically, our insurance subsidiary has generated capital in excess of such needed levels. If necessary, we also have other potential sources of liquidity that could provide for additional funding to meet corporate obligations. Our regulated insurance subsidiary is subject to various regulatory restrictions which limit the amount of annual dividends or other distributions, including loans or cash advances, available to us without prior approval of the insurance regulatory authorities. The aggregate amount of dividends that may be paid in 2023 from our insurance subsidiary without prior regulatory approval is approximately$7.4 million . We anticipate that our sources of capital will continue to generate sufficient capital to meet the needs for business growth and debt interest payments. Additional information is contained in Part II - Item 8, Note 13 of the Consolidated Financial Statements in this report. 54 Table of Contents Total capital was$1,806.4 million atDecember 31, 2022 , including$25.0 million of short-term and long-term debt. Total debt represented 1.38% of total capital including net unrealized investment gains on fixed maturity securities (1.39% of total capital excluding net unrealized investment gains on fixed maturity securities*) atDecember 31, 2022 .
Stockholders' equity was
The Company did not pay dividends in the year ended
The NAIC has established minimum capital requirements in the form of RBC that factors the type of business written by an insurance company, the quality of its assets and various other aspects of its business to develop a minimum level of capital known as "authorized control level risk-based capital" and compares this level to adjusted statutory capital that includes capital and surplus as reported under SAP, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level RBC fall below 200%, a series of remedial actions by the affected company would be required. As ofDecember 31, 2022 , and 2021, the RBC ratio of American Life was 558% and 764%, respectively. OnNovember 22, 2022 , the Company entered into a three-year senior secured revolving credit agreement ("Credit Agreement") with Royal Bank of Canada and other lenders with a capacity of$30 million (the "Revolving Credit Facility"). The maturity date of the Credit Agreement isNovember 22, 2025 . The obligations under the Credit Agreement are secured by a first priority lien on a variety of our assets. The balance of the revolving credit was$25.0 million atDecember 31, 2022 , with$5.0 million unutilized credit. Under the terms of the Credit Agreement, the Company has the option of selecting an applicable variable interest rate of (a) an adjusted term standard overnight financing rate ("SOFR"), plus an applicable margin or (b) a base rate, plus an applicable margin. Depending on our debt to capitalization ratio, the applicable margin can range from 2.50% to 3.25% for the base rate and from 3.50% to 4.25% for an adjusted term SOFR loan. At itsNovember 2022 meeting, the Company's Board of Directors approved the "FHLB Program Recommendations and Strategy Document" that allowed for FHLB funding to be used for spread lending business, beginning in the fourth quarter of 2022. The strategy initially utilizes FHLB advances of up to 5% of American Life's balance sheet. As ofDecember 31, 2022 , we had$29.0 million of borrowings outstanding with theFederal Home Loan Bank ("FHLB").
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As a smaller reporting company, we are not required to provide disclosure pursuant to this Item.
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